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Hedge Fund Definition: 9 Things You Need to Know

Curious what the best hedge fund definition is? Let’s take a look, assuming you’ve already answered the question “What is a hedge fund?

hedge fund definition

According to a recent report by the U.S. Securities and Exchange Commission, “hedge fund” is a term that has been used since 1949 when it was first applied to a fund under the management of Alfred Winslow Jones. His private fund combined short and long term positions as a means of “hedging” exposure to the the market, thus leading to the name “hedge fund.”

A hedge fund is a privately owned company that pools together money from investors and reinvests into a variety of financial instruments. The one and only goal of a hedge fund is to outperform the market, no matter what it takes, within the legal limits of the law.

Note: it is not just enough to outperform the market. Instead, hedge funds want to do so by as much as possible.

The best performing hedge funds often times experience monthly returns of 40 percent or greater.

While many people confuse hedge funds with mutual funds, there are differences to be aware of. For example, mutual fund owners are public corporations, which is not the case with a hedge fund. Additionally, hedge funds are not regulated by the Securities and Exchange Commission. This one detail alone makes investing in a hedge fun a risky proposition.

Of course, it is the risk involved that attracts many investors as they believe that “higher risk leads to greater returns.”

Despite the fact that there is risk involved with hedge funds, the rewards often times win out in the long run. Here are three rewards to become familiar with:

1. With a hedge fund, the manager is compensated based on returns. This is in stark contract to a mutual fund in which fees are paid regardless of performance.

2. Hedge fund managers are well known for using sophisticated investing strategies that allow them to profit even when the stock market is tumbling.

3. Due to a lack of regulation, hedge funds are able to invest in high return, albeit risky, financial vehicles.

Now that you have a better idea of the rewards associated with hedge funds, here are a few risks to be aware of:

4. The ability to lose money quickly is very real.

5. A lack of regulation means that hedge fund earnings are not reported to the Securities and Exchange Commission. While fraud should not be a concern, this does add more risk to the investment.

Hedge funds typically meet the following requirements:

6. Employ a variety of trading strategies

7. Pay a performance fee to the manager(s)

8. Organized as a private investment partnership

9. Made up of an investor base of wealthy organizations and/or individuals with a high minimum investment limit

As an everyday investor you may never have the chance to directly invest in a hedge fund. However, you can still keep track of the best performing and worst performing funds as a means of getting a better idea of how you should approach the market.

The hedge fund definition may sound simple enough, but as you dig deeper you will find many additional details that require your attention.

Recommended reading:

Hedge fund strategies

Top hedge funds

Hedge fund research

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